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How to identify customer contract costs and amortize them

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Customer contract costs represent incremental and recoverable expenses directly associated with obtaining or fulfilling contracts with customers. Under IFRS 15 and ASC 340-40, these costs are not immediately expensed, but instead capitalized and systematically amortized as the related revenue is recognized. This approach aligns expense recognition with revenue recognition and prevents premature expense reporting. Understanding how to classify, capitalize, and amortize contract costs is essential for accurate profit measurement, especially in long-term or multi-deliverable contracts.



Contract cost accounting is governed by specific sections of IFRS 15 and ASC 340-40.

Both IFRS and US GAAP introduced aligned guidance for contract costs in their converged revenue recognition standards:

  • IFRS 15 – Revenue from Contracts with Customers

  • ASC 340-40 – Other Assets and Deferred Costs: Contracts with Customers


These standards identify two types of costs eligible for capitalization:

  1. Incremental costs of obtaining a contract

  2. Costs to fulfill a contract

If the costs meet the criteria for capitalization, they are recognized as assets and then amortized on a systematic basis consistent with the transfer of goods or services.


Incremental costs of obtaining a contract are capitalized if recoverable.

Incremental costs are those that would not have been incurred if the contract had not been obtained, such as sales commissions. These are automatically capitalized if:

  • The costs are incremental (not incurred for other purposes)

  • The entity expects to recover them


This excludes fixed salaries or general marketing expenses, which are not tied to specific contracts.

Cost Type

Capitalizable?

Explanation

Sales commission (per contract)

✅ Yes

Incremental and recoverable

Fixed salary for salesperson

❌ No

Not incremental

Legal fees (general advice)

❌ No

Not contract-specific

Legal fees (contract negotiation)

✅ Yes (if specific)

Directly related to contract

If the contract period is less than one year, companies can expense these costs immediately as a practical expedient.


Costs to fulfill a contract are capitalized if they meet three criteria.

IFRS 15 and ASC 340-40 also allow capitalization of fulfillment costs, provided that they:

  1. Relate directly to a specific contract

  2. Generate or enhance resources used to fulfill the contract

  3. Are expected to be recovered


Examples include:

  • Engineering and design costs

  • Mobilization and setup costs

  • Equipment used specifically for the contract


These costs must not be within the scope of another standard (e.g., inventories under IAS 2 or property, plant, and equipment under IAS 16).

Fulfillment Cost Example

Capitalizable?

Why

Raw materials consumed

❌ No

Should be treated as inventory (IAS 2)

Custom mold for one-time use

✅ Yes

Contract-specific and recoverable

Training staff for general skills

❌ No

Not contract-specific

Site mobilization for contract

✅ Yes

Directly related and enhances capability


Amortization aligns with the transfer of goods or services to the customer.

Once capitalized, contract costs are amortized systematically in line with the pattern of revenue recognition. This typically means over the period of contract performance.


Amortization principles:

  • Use a straight-line basis unless another method better reflects performance

  • Review for impairment at each reporting date

  • Discontinue capitalization if future recoverability is no longer probable


Example journal entry (amortization of capitalized commission):

Dr. Amortization expense (P&L)       10,000  
    Cr. Contract cost asset (BS)             10,000

This aligns the cost recognition with the revenue from the corresponding performance obligations.


Entities must test contract cost assets for impairment regularly.

Impairment testing is required whenever there is an indication that the carrying amount exceeds expected benefits. Under both frameworks:

  • The recoverable amount is compared to the carrying value

  • If not recoverable, an impairment loss is recognized in profit or loss


Expected benefits include:

  • Future cash inflows from the contract

  • Consideration of cost to complete the contract

This ensures that entities do not continue to carry costs on the balance sheet when the contract may no longer be profitable or enforceable.


Disclosure of contract costs improves financial transparency.

Both IFRS and US GAAP require disclosures that enable users to understand the effect of capitalizing contract costs, including:

  • Accounting policy for contract costs

  • Closing balances of capitalized contract cost assets

  • Amortization method and expense recognized

  • Any impairment losses


These disclosures typically appear within the notes on revenue recognition or significant accounting policies.


By capitalizing and amortizing customer contract costs, companies achieve a more accurate matching of expenses to revenues, especially in sales-driven or project-based industries.


However, rigorous criteria must be met, and ongoing assessments of recoverability are essential to ensure compliance. Both IFRS 15 and ASC 340-40 aim to improve comparability and prevent inconsistent cost recognition, bringing greater clarity and discipline to contract-based accounting.


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